Pakistan’s government appears to have discovered yet another way to discourage investment: persuade an industry to spend billions upgrading its facilities, then change the rules so that keeping them running becomes a loss-making proposition. And then have the audacity to thank the effected party, when it had literally dealt them a blow in the dark.
The latest move to shift the burden of the petroleum levy onto refineries is more than another questionable pricing adjustment. It is a damaging signal about how Islamabad understands investment, risk and the sanctity of an agreement. Having spent considerable political capital presenting recently signed refinery agreements as a watershed moment for the country’s investment landscape, the government has now produced a rather spectacular demonstration of why investors might hesitate before taking those assurances seriously.
The arithmetic is ugly. Petrol spreads have already slipped into negative territory. The proposed changes threaten to deepen losses on petrol to levels comparable to, if not worse than, those on furnace oil. Put the two together, and roughly two-thirds of refinery output could find itself in loss-making territory. Apparently, the government’s idea of industrial policy is to encourage investment in upgrading capacity while undermining the economics of operating it.
One wonders what exactly the refinery agreements were supposed to achieve. Was the idea to attract fresh capital, modernise plants, improve product yields and reduce dependence on imported fuels? Or was it to secure investment commitments that could subsequently be treated as convenient places to park the fiscal costs of running the state? If the latter, the government deserves credit for efficiency. It has managed to turn an investment announcement into a cautionary tale before the ink has had time to dry.
The timing makes the decision particularly difficult to defend. Refining is not a business that offers investors the luxury of predictable earnings. Crude prices fluctuate, product cracks swing, inventories generate gains one quarter and losses the next and global supply-demand dynamics can turn a profitable barrel into an unprofitable one with remarkable speed. Refiners understand market volatility; it comes with the territory. What they should not have to contend with is the possibility that their own government will suddenly rewrite the economics of their business to plug a hole in its revenue collection.
There is a difference between accepting market risk and being handed policy risk by a government that has invited you to invest on the strength of a negotiated framework. The former is the cost of doing business. The latter is the cost of doing business in Pakistan.
And this is hardly an industry emerging from a decade of extraordinary profitability. Over the past ten years, Pakistan’s refineries have averaged a return on equity of around 4 percent. Fertilizer companies, by comparison, have earned roughly 26 percent, E&P companies 18 percent, banks 16 percent and cement companies 14 percent.
The numbers tell their own story. Refining has hardly been the most lucrative corner of corporate Pakistan. If the national interest now requires businesses to surrender earnings, why should a sector with one of the weakest long-run returns be among the first to receive the bill?
And if this is indeed the new philosophy of redistributing corporate profits in the national interest, why stop at refineries? Fertilizer companies have earned substantially higher returns over the past decade. Surely, a few billion rupees from their profits could be requisitioned to make naan cheaper. After all, a loaf of bread is arguably far more essential to household nutrition than a liter of petrol. If refineries can be made to subsidize the petroleum levy, perhaps fertilizer companies can subsidize roti. One can only imagine the possibilities once corporate profitability becomes a public utility, available for appropriation whenever the state discovers a worthy cause.
Did refineries make decent profits last quarter? Perhaps they did. Commodity businesses can have spectacular quarters. That is precisely why a single period’s earnings cannot be confused with sustainable profitability. A good quarter does not erase a decade of weak returns, compensate for future losses or make capital expenditure cheaper. Nor does it establish an obligation to return those earnings to the government through an unexpected change in the pricing mechanism.
By that logic, every business enjoying a favorable quarter should brace itself for a visit from the fiscal authorities. Banks have made money. Cement manufacturers have made money. Fertilizer producers have made money. Some sectors have enjoyed substantially better returns for years. Is there a reason they should be spared? Perhaps their profits are somehow more sacred. Or perhaps it is simply easier to extract money from an industry whose pricing is already administered by the state.
That brings us to the bigger problem. The petroleum levy has become an extraordinarily convenient fiscal instrument. Taxing petroleum consumption is easy, immediate and politically expedient compared with the far more arduous task of broadening the tax base, documenting the economy and bringing undertaxed segments into the net. When the tax machinery fails to develop depth, the temptation is to keep squeezing the channels that are already visible.
But a levy is a tax instrument, not a magic wand. Its incidence does not disappear because the government decides to move it around the supply chain. Someone must ultimately bear the cost. If Islamabad wants to collect more from petroleum consumption, it should own that decision transparently. It should not quietly turn refinery margins into a fiscal shock absorber and pretend the industry can absorb the difference without consequence.
There is something particularly perverse about asking a capital-intensive industry to finance the state’s revenue needs just as it is being asked to commit fresh capital. Refinery upgrades require substantial investment and long payback periods. Investors must have some confidence in future margins, policy stability and the regulatory treatment of their returns before committing funds that cannot be withdrawn at the first sign of trouble. If those assumptions can be overturned without warning, the risk premium rises, projects are delayed and capital seeks jurisdictions where the rules are less susceptible to administrative improvisation.
No amount of official rhetoric about billions of dollars in prospective investment can compensate for that. Investors do not commit billions because a government describes an agreement as historic. They commit because expected returns justify the risk. A government that weakens those returns after asking investors to commit is damaging the credibility of the very framework on which its investment pitch rests.
Pakistan can ill afford another self-inflicted wound in a sector already struggling to make a compelling case for modernization. The proposed upgrades are not charitable contributions to the national exchequer. They are commercial investments that must earn a return. If the state wants cleaner, more efficient and competitive refineries, it must create conditions in which those investments make economic sense.
Perhaps the government’s approach is to demonstrate that no profit is too small to be appropriated and no investment agreement too solemn to be revisited. That would certainly send a clear signal to foreign investors. It just would not be the signal Islamabad appears to have intended.
If the national interest requires every profitable business to subsidize the state whenever convenient, the government might consider extending this philosophy to the shipping industry. Freight rates have surged, and shipowners could be in line for an exceptional quarter. Why stop at refineries? Why not identify every sector enjoying a favourable turn in the cycle and ask it to surrender a portion of its earnings? There is always another industry, another balance sheet and another convenient explanation for why the burden should fall elsewhere.
The absurdity is obvious. Exceptional earnings in a cyclical business are not a standing invitation for the state to rewrite the terms of profitability. Nor is the national interest served by making private investment a hostage to immediate revenue requirements.
The answer is not to go easy on corporations for the sake of pleasing shareholders. It is to establish predictable rules, distribute the tax burden fairly and recognize that businesses need a reasonable prospect of earning returns if they are expected to invest. If the government believes the petroleum levy should be collected differently, it should make the case openly and provide a coherent policy framework. What it should not do is spring a surprise on an industry whose investment plans depend on the very margins it is now threatening.
There is a fine line between wizardry and clownery. Wizardry makes the impossible look effortless; clownery makes the obvious look ridiculous. A government that promises a refinery investment renaissance while making the economics of refining materially worse may believe it is performing the former. To investors watching from the sidelines, it increasingly resembles the latter.
And a circus, however entertaining the performance, is no place to invest billions.
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